Finance terms

Earnings Per Share

Earnings Per Share

Everything you need to know about Earnings per Share:

What are Earnings per Share?

• Earnings per share refers to the amount of earnings per each outstanding share of a public corporation’s stock; in the United States, the Financial Accounting Standards Board requires all publicly-traded companies to produce income statements that account for earnings per share for all major categories outlined in the income statement. As a result, all publicly traded companies, in the United States of America, are required to report their earnings per share for their continuing operations, their net income, all extraordinary items on the income sheet and discontinued operations.

• Earnings per share refers to the portion of a company’s profit that is allocated to each outstanding share of common stock. When calculating a company’s earnings per share, it is better to use a weighted average number of shares outstanding because the number of outstanding shares can fluctuate over time.

How do Companies Calculate Earnings per Share?

• The earnings per share formula are different for each report; in general, the earnings per share formula will not include preferred dividends for variables outside of net income and continued operations. 

• In a basic sense, the earnings per share formula will look as such:

o  Earnings Per Share= Profit/ Weighted Average Common Shares

• For calculating the earnings per share of the firm’s net income, the formula will look as such:

o Earnings Per Share= Net Income-All dividends on Preferred Stock/ Average number of outstanding shares

• The earnings per share formula for continuing operations will look as such:

o Earnings Per Share= Income from Continuing Operations/Weighted Average of Common Shares

• The Earnings per Share formula will only include dividends that were actually declared (by shareholders) in the current year. In this case, all declared dividends are subtracted from the earnings per share formula. The exception to this rule is when preferred shares are cumulative, in which case all annual dividends are deducted regardless of their declaration status. Furthermore, dividends in arrears are not relevant when calculating earnings per share.

 

 

PE Ratio: A Brief Guide

PE Ratio: A Brief Guide

What is the PE Ratio?


• The PE Ratio or price-to-earnings ratio is a financial variable that evaluates the price per share relative to the annual net income of the underlying company. As a result, the PE Ratio can alternatively be calculated by dividing the underlying firm’s market capitalization by its total annual earnings. 
• The PE Ratio is a financial ratio used by analysts and investors for valuation purposes: a higher PE ratio means that an investor is paying more for each unit of net income. In these situations, the stock is more expensive compared to one with a lower PE Ratio. 
How do I Calculate a Stock’s PE Ratio?
• The PE ratio is defined as the following formula:
o PE Ratio= Price per Share/Annual Earnings per Share
• The price per share component of the PE ratio is the market price for a single share the underlying company’s common stock. The earnings per share, which is the denominator in the PE ratio, will depend on the type of price-to-earnings ratio utilized. 
o There are three different types of price-to-earnings ratios: Trailing, continued operations, or forward price to earnings. A trailing price to earnings ratio refers to the company’s net income for the recent year (12-month period) divided by the number of shares issued. The trailing PE ratio, instead of net income, uses the company’s operating earnings, which will exclude earnings from discontinued operations, accounting changes or extraordinary items. And lastly, the Forward PE ratio uses the company’s estimated net earnings over the next 12 months. 
Examples of PE Ratios:
• If a stock’s price is $25 and the EPS for the most recent 12 months is $5, the underlying stock has a P/E ratio of 25 divided by 5, or 5. As a result, an investor who buys shares of this stock is paying $5 for every dollar of earnings. Those companies with negative earnings (losses) will have an undefined PE ratio that will usually read as N/A. 
• The ability to compare price and earnings per share for a company enables a prospective investor to analyze the market’s valuation on the stock and its shares relative to its income. Stocks with better forecasts (higher earnings growth) will have a higher PE ratio and vice versa.
 
• Although the PE ratio is an effective tool in analyzing stocks, all companies are different and comparisons between industries and time periods may be inconclusive or misleading. 

Inflation Calculator

Inflation Calculator

Everything you need to know about the Inflation Calculator
What is inflation?
• In regards to economics, inflation refers to a rise in the general level of prices for goods and services offered in an economy over a period of time. When inflation is present in a marketplace, each unit of currency (for example one dollar) buys fewer goods and services. As a result, inflation will erode the purchasing power of money; each dollar is met with a loss of real value regarding its ability to purchase goods or services in a competitive marketplace. 
• The primary measure of price inflation is the inflation rate; this figure is measured and delivered as an annualized percentage change in a general price index over time. 
• Inflation will affect an economy in a number of ways; the effects may be simultaneously positive and negative. Inflation can yield negative effects by decreasing the real value of an economy’s currency and other monetary items over a period of time. This decrease in value will lead to greater skepticism and uncertainty regarding future inflation levels; ultimately this will discourage investment and savings. High periods of inflation may lead to a severe shortage in goods, if consumers begin to hoard out of concern that prices will spike in the future.
• Although there a number of contributing factors, the majority of economists agree that high rates of inflation are caused by an excessive growth of the money supply. That being said, views citing which factors determine the degree of inflation will vary; low or moderate rate of inflation are thought to be attributed to fluctuations in the demand for goods and services, changes in available supply levels and moderate fluctuations in the money supply. 
What is an Inflation Calculator and how do I use one?
• Inflation is a general measure to gauge the prices of goods and services. The predominant variable or measure used to study inflation is the CPI or Consumer Price Index. Released by the United States Bureau of Labor Statistics, the CPI measures changes in the price of consumer goods and services purchased by American households. As defined by the Bureau of Labor Statistics, the CPI will measure the average change over time in the prices paid by consumer for a market basket of goods and services. 
• Using the CPI and other economic measures, the inflation calculator will show a consumer how much his or her money is worth for a given year. That being said, the inflation calculator does not postulate what inflation will be in future years; it simply compares, based on inflation, the value of your money for a given year.
• For example, the average inflation calculator will have 3 boxes where the user will be required to input information. The three boxes are as follows: amount of money, initial year and final year. After the user has entered his or her amount of money in the inflation calculator they must then enter the desired date in which they’d like to begin their comparison (typically a date in the past to show the effects of inflation). Once the date has been selected, the user then enters the current date or the final year.
• If the user inputted $2,500 dollars and 1950 compared to 2010, the inflation calculator would yield a figure of $22,390, meaning $2,500 dollars in 2010 would be worth $22,390 in 1950. 

Profit Margin: A Brief Guide

Profit Margin: A Brief Guide

Everything You Need to Know about Profit Margin:
What is Profit Margin?
• Profit margin, which is also referred to as net profit margin, net margin or the net profit ration, is a quantifiable measure of profitability. In the simplest of terms, a profit margin is the difference between a company’s sales generated and the cost produce each of the units sold. A business entity’s profit margin is calculated by finding the net profit as a percentage of the firm’s revenue. More specifically, the formula for deducing profit margin looks as such: Net Profit Margin= (Net Income/Revenue) X 100. 
• Profit margin is most commonly used for internal comparisons; a company will use its profit margin as a basis point. As a result of its personal characteristics, the profit margin calculation is rarely used to compare the net profit ratios of different entities or business formations. This exclusion primarily stems from the fact that individual business models and their coordinating financing agreements are unique and vary so much that different firms are bound to different levels of expenditures. 
What is the role of Labor Costs in the Profit Margin Equation?
• Profit margin can be calculated in a number of ways; the majority of application will require the total cost of producing a good or service, meaning the inclusion of costs associated with production, raw materials, salaries, wages and equipment. When the underlying company determines how much it costs to produce a unit of the particular good or service it is possible to set a price for the unit. The difference, is thus, found between the sales price and the cost of producing one unit. 
What does the Profit Margin Indicate?
• The profit margin is a fundamental indicator of a company’s pricing strategy and how well it implements and maintains its costs. A low profit margin will indicate a low margin of safety; in these instances, a higher risk that a decline in sales will eliminate all profits is realized. These situations commonly result in a net loss or negative margin. 
• By calculating their profit margin, a company can accurately evaluate its position; the profit margin enables the company to analyze if its growing, maintain its current market share or losing its foothold. 

What to know about Leverage

What to know about Leverage

What is Leverage?
• In finance, leverage refers to any technique to multiply gains and losses. A common way to attain leverage is by borrowing money, purchasing fixed assets or partaking in derivative contracts. The following examples will represent common situations where leverage is used:
o A business entity may leverage its revenue by purchasing fixed assets. These purchases will increase the ratio of fixed to variable costs, meaning that a fluctuation in revenue will result in a larger change in operating income. 
o Hedge funds will typically leverage their assets by purchasing and selling derivative contracts. 
o A public company may leverage its equity by borrowing money. The more money the corporation borrows, the less equity capital it will need. Any profits or losses, in this scenario, are shared among a smaller base and are proportionately larger as well. 
How do you Measure Leverage?
• Leverage, as a term, carries many different definitions across a number of fields. For instance, accounting leverage refers to total assets divided by total assets minus total liabilities. Economic leverage, in contrast, is the volatility of an equity divided by the volatility of an unlevered investment in the same group of assets. 
• In finance, leverage is often referred to as operating income divided by net income. Within this definition, analysts will utilize operating leverage to estimate the percentage change in operating income for a one percent change in revenue. The product of these two forms of leverage is referred to as total leverage, which is used to estimate the percentage change in net income for a one percent change in revenue. 
Risks Associated with Leverage:
• The popular prejudice attached to leverage is that people who borrow a significant amount of money often end up defaulting or falling into a financial mess. The primary issue with that observation is that these investors are not leveraging anything; they are simply borrowing money for consumption.
• In finance, the traditional practice is to borrow money for the purpose of buying assets that yield a higher return than the interest on the debt. That being said, there are risks to leverage, the most obvious being a case where an investor experiences multiple losses. 
• For example, a company that borrows too much money may face bankruptcy if the entity’s investments all lost money or if they borrowed such funds during a business downturn. 
• If an investor purchases a stock on 50% margin, he or she will lost 40% of the principal if the stock declines 20%–this is the risk associated with leveraging investments.